Why it pays to be active in this fixed-income world

Portfolio manager says it's time to get creative in order to generate an income that's palatable

Why it pays to be active in this fixed-income world

Finding income in a fixed-income world is something that will exercise portfolio managers during this low interest-rate environment.

Ninepoint Partners believe they have the right strategies and skill to excel in these challenging times. The firm, which offers the Ninepoint Diversified Bond Fund and Ninepoint Credit Income Opportunities Fund, also brings experience at managing alternative investment solutions that strive to offer investors better diversification that’s uncorrelated from traditional asset classes.

Mark Wisniewski, partner, senior portfolio manager, oversees the firm’s fixed-income strategies, and said the biggest challenge right now is the low yield of government bonds, which at best provide ballast.

This means, he added, that managers have to be more creative in how they generate an income that’s palatable. Interest rates are not going anywhere for the foreseeable future, with the consensus that the Bank of Canada and Fed are unlikely to be raising rates for another five years. In addition, the amount of debt created through this crisis will be significant, so government have little interest in rates going anywhere fast.

Wisniewski said that, in a different strategy from 2008, central banks are buying credit – all investment grade so far. Given we are in the midst of a COVID-19 second wave, there is the distinct possibility they will significantly up their bond- and credit-buying programs further, or even cap yields or control the shape of the yield curve.

“That’s a risk,” he said. “[But] what we are dealing with now is central banks very, very keen on keeping interest rates low to protect the economy and, obviously, to generate inflation.”

So how do managers deal with this? Where do they get that income? While government bonds are required to reinforce the portfolio during the tough times, the shackles are off somewhat when the expected recovery kicks into gear. That means it’s vital to be active.

Wisniewski said: “When we want to be defensive and want to dampen volatility, we own government bonds. But when we get into the early part of the recovery, we're in an environment where we probably want as little government bonds as possible, or none.

“And it's not just buying a basket of government bonds, it's where you buy them. If we're worried about going into recession, we typically want to get the biggest bang for our buck. We look around the world for government bonds, so we just don't buy Canada, we'll buy U.S., France, Germany, Switzerland, we'll buy anything … it all comes down to how much we're getting paid in a government bond relative to what we get in Canada.”

Then there’s credit. The portfolio manager says being active in this space means less volatility and the potential for a ton more income. He pointed to a Royal Bank AT1 deal a couple of weeks ago that yielded 4%, which stacks up favourably to a 10-year Canada bond at 77 basis points.

Many of the traditional index bond funds are also overly diversified and own too many low-yielding securities in too many sectors.

He explained: “We like to overweight cheap sectors; things that get beaten up in certain environments where we think ‘okay, we're in an improving environment right now, let's overweight to a cheaper sector. Should we be overweighting to cruise lines or to air carriers? We don't know but those are the types of questions we ask ourselves.”

Ninepoint also likes “fallen angels”, typically companies that fall out of investment grade into the high yield bucket, meaning index managers have to sell them. Also, when people are liquidating things for what Ninepoint believes are wrong reasons, it likes to take advantage.

Wisniewski added that split ratings tend to mean wider spreads, while smaller companies or issues that are under-owned can also be got at a discount because they are just too small for the big funds to invest in.

He said: “Very similar to government bonds, we look around the world for opportunities. Sometimes we can get great companies that, when we hedge the currency, actually earn way more than a similar quality business in Canada.”

Other strategies include taking profit to reinvest and short-selling government bonds to effectively reduce the duration of the portfolio.

He added: “We can also take the cash from the short of the government and leverage, We take that cash and use it to buy something else to enhance the yield in the portfolio. Lleverage when used prudently is important, short-selling governments to immunize against duration moves is also important.”